Loonie will hit parity with U.S. dollar in few months: analysts

LianaB. Baker

SAN FRANCISCO (MarketWatch) -- The Canadian dollar is on track to hit parity with the U.S. dollar, a rise that would underscore the strength of Canada's economy compared with that of the United States, as well as the country's vulnerability to swift changes in commodities prices.

Analysts are forecasting that the Canadian dollar will trade on equal footing with the U.S. dollar within the next few months, largely based on investor demand for assets linked to rising commodities prices.

The loonie, the nickname for the gold-colored coin that replaced the paper dollar in 1987, is now trading at 94.11 U.S cents. It would have to rise about 6% to trade at one American greenback, or at parity.

"Our forecast is for [the loonie] to hit parity by the end of the first quarter," said David Watt, currency strategist for RBC Capital Markets. "There's a chance it could hit before that."

Some are forecasting the Canadian dollar will shoot well above its U.S. counterpart.

Michael Woolfolk, senior currency strategist at BNY Mellon, said he expects the Canadian dollar to hit parity by midyear and rise to $1.10 U.S. dollars by the end of the year.

Such gains would increase the purchasing power of Canadian consumers. But they could curb Canada's export growth and cool inflation, taking pressure off the Bank of Canada to raise rates. Higher rates tend to make a currency more valuable.

The currency's gains also may be checked if Chinese efforts to slow lending growth foster more concerns about the pace of the global economic recovery. That's what happened last week, as expectations Chinese authorities were moving to raise borrowing costs caused a 4.7% drop in oil futures and a 2.3% decline in the loonie.

The loonie fell again Tuesday after reports that Chinese authorities had required some banks to restrain lending -- a blow to metals and other commodities prices. Read more on China's moves.

"If China is tapping the brakes now, that would certainly upend the bullish views on commodities," Watt commented.

Loonie takes flight

Rising prices of commodities like oil and gold, as well as a weak U.S. dollar, helped drive up the loonie 22% by the end of last year from the March lows.

Plus, investors sought the loonie to get exposure to Canadian economic strength. Its economy experienced a less severe recession than the United States, with no housing market crash. Its banking sector avoided the type of debilitating financial crisis experienced in the States as well as in the United Kingdom.

"The Canadian economy is not as structurally impaired as the U.S. or the U.K.," according to RBC's Watt. "It creates a sense that Canada is less exposed to the fickleness of foreign investors that are causing uncertainty in other locations."

Some countries are diversifying their reserves into Canadian dollars. Russia, which has been outspoken about wanting to unload some of its U.S. dollars that it makes exporting oil and natural gas, said last week that it was buying loonies.

A rise to equal weighting with the U.S. dollar would bring the loonie back to a level last sustained in May 2008. When it hit par nine months before, in September 2007, it had matched its U.S. counterpart for the first time in 31 years.

Further weakness in the American dollar, which fell about 16% from early March through the end of last year, is likely, some analysts say.

They're expecting the buck, which has risen 0.9% this month as measured by the U.S. dollar index
DXY, +0.53%
to reverse lower once U.S. stocks start rising again.

Such a dynamic would be in keeping with a trend in place for most of last year, when the greenback fell as investors added to "riskier" positions such as stocks, emerging markets and other assets.

"Once the U.S. stock market resumes its uptrend, the U.S. dollar will continue its downtrend," said Katherine Beattie, a senior technical analyst who tracks currencies for Action Economics. "As the U.S. dollar weakens, the Canadian dollar will just go to par."

Since March, the U.S. dollar has declined 18% against the Canadian dollar, while the S&P 500 Index
SPX, +0.32%
gained 64% and oil has doubled.

Other commodity-based currencies have fared even better against the greenback: The Australian dollar gained 42% against its American counterpart since March, and the New Zealand dollar gained 44% over the same period.

A few years ago, American visitors to Canada enjoyed 40% discounts north of the border. Those days could be over soon. "It's so difficult to stop a currency when it's in a very strong mood," Beattie of Action Economics said.

Rate hikes

Key to expectations of a stronger loonie is the Bank of Canada, which has kept interest rates at a record low of 0.25% since April. The central bank has said it has no plans to move rates until at least the end of the second quarter.

The Bank of Canada isn't anticipated to take any extraordinary measures to weaken the loonie, and it will probably raise Canadian interest rates when the U.S. Federal Reserve does so later this year.

Other factors could derail the loonie's rise, though. Kathy Lien, director of currency research at Global Forex Trading, said that recent trade and employment data out of Canada shows that the recovery is not as strong as it was originally thought.

"All the reasons that the loonie would hit parity have been thrown out of the window," she added.

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